Copy trading is a unique investment method which enables an investor in the financial market to automatically copy the trades executed by a successful trader so as to replicate the trader’s performance in his own trading account.
Unlike investing in managed accounts where the investor gives his money to an account manager, in copy trading, the investor retains and manages his money by himself. He simply needs to open a personal trading account with a broker that supports copy trading, subscribe to a copy trading platform, find a successful trader of choice, and link his account to the trader’s own. There are settings through which he can input his preferred risk and money management parameters.
The key components
While there may be some little variations, here’re the main components of copy trading.
- The market: Copy trading started in the forex market but with the advent of CFDs, it has spread to other financial markets such as stocks, indices, commodities, bonds, and cryptocurrency
- The broker: This is very a very important component. Without a broker, you can’t invest in the financial market since you need one to open a trading account. You need a broker that supports copy trading.
- The successful trader: This is the signal provider who you want to copy his trades. The platform provides you the data with which to evaluate the performance of the trader. The depth, accuracy, and reliability of these data, obviously, are some of the most important elements for a correct selection of the best traders to copy.
- The investor: You are the investor. Every investor has his own objective and risk tolerance. Your job is to understand how to translate your goals and risk management into practical and specific choices.
- The copy trading platform: This is the platform that links your account to that of the signal provider. It acts as a broker between your broker and the signal provider’s broker.
How does the trade copying process work?
The process is all automated and happens in a few tenths of a second. It works as follows:
- The signal provider opens a new trade, and his broker sends the data of the same trade to the copy trading platform.
- The platform receives the data of the new trade, selects the investors who are copying the signal provider, and verifies their personal replication settings.
- The platform then sends to each investor’s broker the details for the opening of the new trade but modified according to the client’s settings.
- Each investor’s broker opens the order on its customer’s trading account.
How to assess the Signal Provider
When assessing the performance of a signal provider, you need to pay serious attention to these questions:
- How long has he been trading?
- What’s the shape of his equity curve?
- What’re his maximum daily, weekly, and monthly drawdowns?
- How many instruments does he trade — does he specialize on one or diversify with many?
- How many positions does he usually keep open simultaneously?
- How many trades does he execute on average per day or week?
- How long does he keep them open on average?
- What’s his average profit and loss?
- What is his risk/reward ratio?
What to do as the Investor
The beauty of copy trading is that you have your funds and you’re the manager. You then have to decide what your objectives for the funds are, what risks you are willing to take, and the best ways you can manage your investments to maximize returns.
The factors which you need to focus on to develop as an investor in copy trading are:
- Declaration of goals and objectives
- Recognition, analysis, and management of risks
- A good money management plan
- Search and selection of signal providers
- Choosing the right settings for each signals replication
- Implementation of a robust growth strategy
Are there any risks?
Copy Trading is a form of investment, and as with any type of investment, you are putting your capital at risk. Here are some of the risks you may have to deal with in copy trading.
- Ignorance of how the platform works: Pay attention to the platform’s settings.
- Risks associated with the signal provider’s strategy: You need to dig deeper when assessing the signal providers. Avoid those with very high win rates.
- Capital allocation risks: To minimize losses, maximize gains, and maintain a proper risk level, you need to have a good capital allocation plan.
- Portfolio control risks: You must find a way of monitoring and balancing your portfolio from time to time.
Copy trading offers a unique and beautiful way to invest in the forex market by leveraging on the skills of a successful professional trader while still retaining complete control of your money. Furthermore, you also decide your risk parameters and exposures.
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